(Bloomberg) -- Traders are piling into bets that a new Federal Reserve chair and the release of delayed economic data this month will support Donald Trump's calls for lower interest rates.
In the US futures market, demand is building for short-term curve structures linked to the Secured Overnight Financing Rate, which closely tracks perceived outcomes of Fed interest rate decisions. The wagers reflect the potential for monetary policy easing to gather pace after chair Jerome Powell's term ends in May. The June 17 announcement will be the first under a new central bank chief.
The new positions started to build after White House National Economic Council Director Kevin Hassett emerged as the frontrunner to succeed Powell. Trump said Tuesday that the race is "down to one" while referring to Hassett as a "potential Fed chair" during a cabinet meeting. He said he would announce his decision early next year.
The announcement "will create a 'shadow Fed chair'," Kristina Hooper, chief market strategist at Man Group, wrote this week. "This could complicate the Fed's ability to communicate monetary policy and could create some confusion for markets at a time when they need clarity."
Traders in the leveraged futures market are already gaming out the scenarios with a huge buyer emerging Monday in one SOFR futures fly — the largest trade seen in that particular structure in more than a year. Recent sessions have also seen elevated activity in 3-, 6- and 12-month SOFR spreads, as traders look to target more rate cuts.
Delayed Data
It's not just the next Fed chair announcement driving activity across futures spreads. Goldman Sachs strategists are looking to hedge ahead of the November labor market data due Dec. 16, just before the January policy meeting. The data, delayed by the US government shutdown, could spur more dovish bets if they confirm recent signs of softening.
"We continue to see greater asymmetry for the front-end to pull forward cuts given the trend in labor market slack measures," strategists including George Cole said in a Nov. 28 note.
They favor positions benefiting from a curve steepening by targeting short-dated futures via SOFR Dec26/Dec27 spreads and further out the curve with conditional 2s10s bull steepeners. These bets will gather further traction if Hassett is confirmed as the next Fed chair.
Wagers on a dovish policy shift and a ramp-up in December rate-cut odds pushed 10-year Treasury yields near the 4% mark last week. US Treasuries held marginal gains late Tuesday, bouncing from early losses that saw the 10-year yield briefly topping 4.11%, the highest level in nearly two weeks.
Jack McIntyre, portfolio manager at Brandywine Global Investment Management, said that cutting rates while inflation is still above the Fed's target could drive yields on long-end Treasuries higher, even as short-term rates fall.
"If Hassett is confirmed, the most likely outcome is bear steepening," said McIntyre. "I think of myself as part of the bond vigilantes. My job is to send a message to the administration. Do we need to send that message now? It's too early to say. For me, it's still wait-and-see."
Here's a rundown of the latest positioning indicators across the rates market:
JPMorgan Survey
For the week ending Dec. 1, investor long positions dropped nine percentage points, with shorts rising 3 percentage points. As a result, the net long position dropped to the fewest since Nov. 3.
New Risk in SOFR Options
In SOFR options out to the Jun26 tenor, activity has focused around the 96.3125 strike following flows over the past week for new risk including a buyer of the SFRZ5 96.25/96.3125 call spreads and SFRZ5 96.3125/96.375 call spreads. Flows also included a buyer of SFRZ5 96.3125/96.375 2x1 put spreads as traders look to position around the Dec. 10 policy meeting, where currently around 22 basis points of rate cuts are priced.
In SOFR options across tenors out to the Jun26 contracts, the 96.25 strike remains the most populated due to continued demand for upside call structures involving the level in Dec25 options. There's also a large amount of open interest in the Dec25 96.50 and Dec25 96.375 calls. For large outstanding put structures, the Dec25 96.25 and Dec25 96.1875 put strikes are significantly populated.
Treasury Options Premium
The premium paid on options to hedge Treasuries over the past week has continued to drift around neutral. Premium in the front and intermediates of the futures strip continues to slightly favor calls over puts, indicating traders paying more to hedge a Treasuries rally in the front end and belly of the curve versus a selloff.
--With assistance from Carter Johnson and Ye Xie.
(Updates with charts and additional context.)
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